Sole Trader Vs Limited Company as a Tradesperson

As a tradesperson, there is always the question of whether you should trade as a sole trader or a limited company. In this article, we will take a look at the differences between the two.

We will go over the pros and cons of a sole trader and the pros and cons of a limited company. The information in this article should help you to decide which route is best for you.

What is a Sole Trader?

In this section, we will go over what it means to be a sole trader. If you're unsure of what a sole trader is, read on to find out everything you need to know.

If you register as a sole trader, you run your business as an individual, and you are self-employed. All of the profits that you make from your trade are yours to keep minus the taxable amount. You are personally responsible for any losses that incur in the business. You must also follow some specific rules on running and naming your business.

When do you need to register as a sole trader?

You will need to set up as a sole trader if any of the following apply:

• You are not setting up a limited company
• You earned over £1000 from self-employment in the last tax year
• You need to prove that you're self-employed
• You want to make voluntary Class 2 National Insurance payments in order to qualify for benefits

How to set up as a sole trader

If you believe that being a sole trader is right for you, you will need to set up officially. To do this, you will need to tell HMRC that you pay your taxes through self-assessment, which will involve filing a tax return every year. Sole trader registration is a very simple process.

As a sole trader, you will need to do all of the following:

• Keep records of the sales and expenses of your business
• Send a self-assessment tax return every year
• Pay Class 2 and Class 4 National Insurance and pay Income Tax on your profits

VAT rules for sole traders

If you have a turnover of over £85,000, then you will need to register for VAT. You can register for VAT voluntarily if it suits the needs of your business. An example would be if you sell to other VAT-registered businesses and you want to reclaim the VAT.

Naming Your Business

You can use your own name for your business if you are a sole trader or choose another name if you prefer. It's not essential that you register your name, however you must include your business name on all official paperwork, such as invoices and letters.

There are some rules when it comes to naming your business as a sole trader. Sole traders must not do the following when naming their businesses:

• Must not include 'limited', 'limited liability partnership', 'LLP', 'public limited company', or 'plc'
• Must not be offensive in any way
• Must not be the same as any existing trademarks

Your business name should also not contain any sensitive words or expressions. It also must not suggest a connection with government or local authorities unless you have permission.

The Pros and Cons of a Sole Trader

There are several sole trader advantages and sole trader disadvantages. Below is a list of the pros and cons of a sole trader:

PROS

You Have Full Control

When you're a sole trader, this means that you have more control. You can run your business exactly the way you want to without worrying about interference from anyone else. You don't need to consult shareholders or directors when you want to make business decisions. You can make all of the decisions and act quickly to meet the needs of your clients.

Ownership Over Profit

When you're a sole trader, all of the after-tax profits are yours to keep. You won't need to worry about splitting the profits with other shareholders so, if you work alone, you can maximise your potential profits and ensure the costs are low.

It is Easy to Set Up as a Sole Trader

Another reason why many people choose to be a sole trader over a limited company because it is so easy to set up. The only thing that you need to do is let HMRC know that you are self-employed by registering for self-assessment as a sole trader and choose a name for your business. You can essentially start trading instantly, providing you have all of the relevant industry-specific licenses.

There is Less Admin to Worry About

It is easy to set up as a sole trader, as it requires less paperwork, which means that there is less admin overall. As a sole trader, you need to keep accurate records of your expenses and sales. However, you will only need to submit a self-assessment tax return.

You Have More Privacy

If you own a limited company, certain details about the directors are visible on Companies House for the public to view. This means that anyone can see your information and your business details. A sole trader, on the other hand, is granted privacy by the HMRC taxpayer confidentiality rules. Your private and business information won't be visible to the public, so your competitors will not be able to view any information about you.

CONS

Debt Liability

The biggest disadvantage of being a sole trader over a limited company is that you are responsible for all of the debts incurred through the business. You are legally responsible for all of your business elements, which could put your personal assets at risk.

Financing Can Be More Difficult

Sole traders are able to offer shares in their business, so this means that they can find it more difficult to raise much-needed capital. If you choose to be a sole trader, you will most likely have to turn to financial organisations such as banks when you need financing.

You May Have Less Free Time

As a sole trader, you are responsible for everything to do with your business. This can make it difficult for you to take a break or go on holiday. This also means that you are unlikely to earn money whenever you can't work. Whether that is due to sickness, injuries, or some other reason, it is important to consider if this works for you.

Less Flexibility with Taxes

Limited companies tend to be more tax-efficient than sole traders as they allow the income to be maximised and the tax to be minimised. Sole traders have the same tax status as individuals with the same tax-free personal allowance. You pay tax on any income above this number and National Insurance contributions will also be payable.

Your Business May Be Less Appealing to Clients

Sole traders can sometimes be seen as less professional than limited companies, making clients less likely to work with them. This may mean that you could struggle to get work or find it difficult to get bigger jobs. Having to find and chase clients can be time-consuming and may not always work out.

What is a Limited Company?

In this section, we will go over what it means to be a limited company. If you're unsure of what a limited company is, read on to find out everything you need to know.

A limited company is a type of business that is legally separate from the owners. In the UK, a limited company must be incorporated at Companies House. This allows the business to be a separate entity in its own right with a unique company registration number.

As a limited company is separate from the owners by law, this means:

• The company is responsible for its own actions and can sue and be sued
• The limited company can enter into contracts in its own name, including the employment of staff
• The company is responsible for paying its own liabilities and debts
• The company has the legal right to the money it makes from sales and can keep its profits

The owners of a limited company are protected by limited liability. This means that, in most cases, the private owners of the business are protected as the business is a separate entity in its own right.

There are several different types of limited companies. Below, we will take a look at the different types as well as how to set up a limited company and the taxes for a limited company.

Private company limited by shares

What is a private limited company? The majority of limited companies are private. This is where ownership of the company is divided into shares that are distributed between the shareholders.

Each shareholder can purchase one or more shares in the company. Their liability is limited to the amount they paid for these shares.

In many private companies, there is just one share that a single shareholder owns. This means that the shareholder owns 100% of the business and can control it. In other companies, there are more shareholders than just one. Each shareholder will own a percentage of the business. They are entitled to voting rights and the rights to any profits paid out as dividends depending on how many shares they own.

There is no maximum limit on the number of shares that a company can have and. Therefore, there is no limit on the number of shareholders in a company. Private limited companies legally cannot offer shares to the general public. The shareholders of a limited company appoint directors to manage the business, although many shareholders appoint themselves as directors.

This type of business is extremely popular amongst small and large commercial businesses as it combines the potential share in profits with a clear restriction on financial liability. Shareholders are only responsible for what they've agreed to pay for the shares, so their personal assets will not be at risk if the business suffers.

Public limited company

This type of company is divided into shares like a private limited company. The liability of shareholders is usually applied to the amount they have paid for their shares. Before a public limited company can trade, it must have issued shares with a combined total value of at least £50,000. It will also need to have at least two directors and a company secretary.

Public limited companies can offer shares to the general public, and some companies also list their shares on a stock exchange. This type of limited company is usually not suited to small or new businesses but, larger and more well-established businesses.

Private company limited by guarantee

Private companies that are limited by guarantee do not have shareholders. These companies have guarantors instead who agree to pay a fixed amount towards the company's debts. This guarantee must be settled if the company can't pay its bills. In most companies with a guarantee, this guarantee is usually a nominal sum, such as £1.

Typically, that is the limit of each of the member's liability. This means that their personal assets are protected like a company that is limited by shares.

Guarantors appoint directors to manage the company. However, guarantors can also appoint themselves as a director if they wish. This type of company is used in many non-profit organisations. Any surplus income that is generated is usually reinvested in the business rather than being withdrawn as income.

How to set up a limited company

If you believe that a limited company may be the best option for you and your business, you will need to set up as a limited company. To do this, you must do the following:

• Choose a company name
• Gather all of the relevant information needed to set up your company
• Prepare the memorandum and articles of association for the company
• Submit the incorporation to Companies House
• Wait to be accepted on Companies House and receive your certificate of incorporation
• Hold the company's first board meeting and write up minutes
• Establish the statutory registers required for the company
• Issue share certificates to each of the shareholders

Taxes for limited companies

As a limited company is a separate legal entity in its own right, it is subject to its own taxes. Once the business is incorporated, you will need to register for corporation tax with HMRC. Corporation tax returns must be filed regularly, and corporation taxes must be paid to HMRC.

The company may also be subject to some other taxes, including the following:

• Pay as You Earn via the payroll scheme if the company employs staff
• VAT if the turnover exceeds the VAT registration threshold or if you opt to register voluntarily
• Capital gains tax is business assets are sold
• Other taxes depending on the nature of the business and its trade

If your tax returns are not submitted or paid on time, there may be penalties and sanctions for a company and its directors. Most limited companies will appoint an accountant to handle their finances and ensure that all payments and returns are made on time.

The Pros and Cons of a Limited Company

There are several advantages and disadvantages of a limited company. Below is a list of the pros and cons of a limited company:

PROS

You Could Pay Less Tax

As opposed to sole traders, limited companies do not have to make payments on account. Limited companies pay corporation tax on profits at a lower rate than the general income tax that sole traders pay. Limited companies also don't have to pay national insurance. However, limited companies are not entitled to personal allowances, so the differences in tax savings may not be substantial.

You Could Claim More Tax Relief on Expenses

When you register as a limited company, you are entitled to more tax relief on some costs. An example of this is that a limited company can claim certain food and drink expenses at the cost of the business. This is different to sole traders who can only claim this type of tax relief on a few occasions in certain specific situations.

It May Be Easier to Attract Investors

If you are looking to secure some form of investment in your business, then incorporation could be the right path for you. If you own a limited company, you will be able to sell shares in your business. This is different to sole traders who can only get investments through a complex partnership process.

You Will Have Liability Protection

A limited company is a separate legal entity to you as a person. This means that the company can own assets, pay bills, and incur debts in its own right. With this in mind, if the company is ever sued, your personal possessions would never be at risk.

CONS

You Will Encounter More Financial Admin

Sole traders only need to file their self-assessment tax returns once each year. This is different to limited companies as these need to file a set of accounts, a confirmation statement, and a corporation tax return.

Each director will usually need to file their own self-assessment tax return as well. If you are down as an employee for your company and take a salary, you will also need to register the company as an employer and set up and run payroll.

Directors Have Certain Legal Obligations

The directors of the company have an obligation to safeguard the company's assets. It would also fall on you to make a decision to cease trading if the company can no longer survive. If you fail to meet any of these essential responsibilities, you may be fined or even go to prison.

You Will Face More Rigid Tax Rules

Unlike sole traders, directors of a limited company cannot simply withdraw money from the business bank account. When a limited company falls into a loss, it can only use that loss against profits. Sole traders, however, can use their losses to decrease what they pay for income tax.

You Will Have Less Privacy Than a Sole Trader

Some information about a limited company's accounts are published on Companies House, and this information is available for anyone to view. This means that your finances and figures will be visible to the public as well as the registered address of your company.

Conclusion

As you can see, there are many differences between a sole trader and a limited company. Hopefully, this article has provided you with a better idea of which business style is best for you.

Sources

https://www.gov.uk/set-up-sole-trader
https://www.informdirect.co.uk/company-formation/what-is-a-limited-company
https://gorillaaccounting.com/blog/what-are-the-pros-and-cons-of-being-a-sole-trader